Monday, October 17, 2011

Here are the details surrounding the separation of research and investment banking:

To ensure that stock recommendations are not tainted by efforts to obtain investment banking fees, research analysts will be insulated from investment banking pressure. The firms will be required to sever the links between research and investment banking, including prohibiting analysts from receiving compensation for investment banking activities, and prohibiting analysts' involvement in investment banking "pitches" and "roadshows." Among the more important reforms:

The firms will physically separate their research and investment banking departments to prevent the flow of information between the two groups.

The firms' senior management will determine the research department's budget without input from investment banking and without regard to specific revenues derived from investment banking.

Research analysts' compensation may not be based, directly or indirectly, on investment banking revenues or input from investment banking personnel, and investment bankers will have no role in evaluating analysts' job performance.

Research management will make all company-specific decisions to terminate coverage, and investment bankers will have no role in company-specific coverage decisions.

Research analysts will be prohibited from participating in efforts to solicit investment banking business, including pitches and roadshows. During the offering period for an investment banking transaction, research analysts may not participate in roadshows or other efforts to market the transaction.

The firms will create and enforce firewalls restricting interaction between investment banking and research except in specifically designated circumstances.

To ensure that individual investors get access to objective investment advice, the firms will be obligated to furnish independent research. For a five-year period, each of the firms will be required to contract with no fewer than three independent research firms that will make available independent research to the firm's customers. An independent consultant for each firm will have final authority to procure independent research.

To enable investors to evaluate and compare the performance of analysts, research analysts' historical ratings will be disclosed. Each firm will make its analysts' historical ratings and price target forecasts publicly available.

This is going to be a running post on articles talking about the need for bank capital.

I will also be posting articles under the arguments for and against a strict bank capital requirement. Like any policy we need to understand the costs and benefits of added bank capital. The costs are reduced lending, the benefits are a reduced likelihood of a financial crisis. Here are the results from the Basel panel.

Here is recent article from the WSJ talking about recent moves toward more bank capital. Of course Citi Bank does not like the requirements.

Here is the first article from The Economist. This article talks about increased bank capital during the onset of the financial crisis. How much capital is enough?

The Basel Accord has been an attempt to standardize bank capital requirements across countries. Here is an article talking about Basel III.

A panel discusses the effects of bank capital requirements on economic growth. The pros are simple, more capital reduces the likelihood of a bank become insolvent due to large loan write downs. The costs are simple, the more capital reduces the return on equity for bank owners.

I'm in favor of strict capital requirements for all bank-like institutions. I believe the financial system in a large way acts as a public good. Because of the problems posed by banks failing to fully account for the costs of risky behavior (yes, largely created by the types of regulations we currently have) large banks do not recognize the costs to society. I view capital requirements as an easy but highly effectively way of minimizing regulations while allowing banks to serve society (i.e. channeling funds from borrowers to savers). I like these requirements mainly because banks still have a choice for the types of assets they want to hold. If banks want to undertake in subprime lending they can, but it needs to be supported by added capital. Will this slow down growth, probably in the short run, but in the long run it will lead to fewer financial crises. Given the recent number of crisis that could have been avoid if banks were holding adequately capital, I view the long run benefits as a necessary.